Inflation and the British economy

There is an excellent article in today's FT by Chris Giles. Unfortunately this is behind the FT paywall so I don't think clicking through will help most of my readers.

Mr Giles considers what has gone wrong with the British economy over the last year - since growth forecasts are being consistently revised downwards. Two explanations are often offered - "it's the Euro crisis" or the government is cutting "too far, too fast". In fact both are wide of the mark. The simple fact is that while rates of pay have stuck broadly on forecast (2% increase), consumer prices have increased by more (over 5% compared to just over 3%). The gap is plenty enough to explain the lowering of real terms growth.

Why have prices shot ahead of forecast? Mainly external factors to the British economy - oil prices, global prices for food and clothing and so on. I really don't like calling these price rises "inflation". Inflation suggests a degrading of money which, inter alia, makes debts easier to afford. But incomes aren't keeping up, so debts aren't eroding by more than the 2% a year or so that incomes are rising. Similar considerations apply to government debt - taxes largely depend on income. VAT is an exception - but many benefits (like pensions) are linked to the rate of increase of consumer prices - so the national debt doesn't get any more affordable.

The economic pain of these external price rises is being spread widely. Surely the Bank of England is right not to tighten policy - which would only cause unemployment and concentrate the pain on an unlucky few. Our comparatively low rate of unemployment, compared to previous crises of this economic scale, is one of the wonders of the British economy.